Covenant Weekly Market Synopsis for March 15, 2019

March 18, 2019

Last Week Today. Fed Chair Jerome Powell’s interview on 60 Minutes revealed little new information and was likely intended to clarify the Fed’s current views. Powell did take the opportunity to emphasize confidence in the US economy (while acknowledging it will grow at a much slower rate in 2019) and stress the independence of the Fed “We will never, ever take political considerations into effect.” Powell will have another opportunity to elaborate on the Fed’s monetary policy this Wednesday, following the FOMC meeting. | On the trade front, it looks like a deal with China won’t happen before April. In the meantime, President Trump countered insiders’ claims about Trump’s supposed desperation to complete a deal stating “[he’s’] not in a rush to do China trade deal.” On the other hand, Chinese media cited “substantive progress” in trade talks. | Following weak economic data last week, the Atlanta Fed’s Q1 GDP forecast fell to 0.4%, and the NY Fed’s forecast dropped to 1.37%. | For those of you that may have been out on Spring Break or otherwise missed it, last week we published our semi-annual Economic Review and Outlook.

After taking a shot in the chin the prior week (suffering its worst weekly performance in 2019), the S&P 500 shook off the blow and rallied 2.9% to end the week at its highest level since October 9th. Growth names led the rally, specifically in technology, and the Nasdaq Index surged 3.8%. Global equities chased US stocks higher, though generally underperformed their domestic counterparts. Fixed income investments joined the party as well, as yields across the US Treasury curve declined, and high yields spreads tightened further. The commodity complex presented a mixed bag as gold (+0.3%), copper (+0.3%), and crude (+4.4%) posted gains, while silver (-0.3%) and natural gas (-2.4%) declined modestly.

Black Gold. The International Energy Agency (IEA) issued its latest report on Friday forecasting the “second wave of the U.S. shale revolution” will result in the United States accounting for 70% of the rise in global oil production and nearly 75% of the expansion in liquefied natural gas (LNG) trade in the next five years. The report also predicts that U.S. exports of crude oil and petroleum products will nearly double to approx. Nine million barrels per day by 2024. If the forecast comes to fruition, the U.S. will not only export more oil than Russia but could potentially surpass the current global export leader Saudi Arabia. On the demand side, the IEA’s current forecast acknowledges that electric cars and increased fuel efficiency will modestly reduce demand for gasoline. However, rising consumption for petrochemicals (e.g., plastics) and jet fuel demand will offset automobile-based demand erosion. All in, the IEA is forecasting global demand will increase by an average of 1.2 million barrels per day over the next five years, which is in line with the recent trend).

False Idol. Members of Congress and mainstream press are increasingly mentioning Modern Monetary Theory (MMT), but what is it and why is it drawing so much attention? MMT is a macroeconomic theory that was developed in the early 1990s, but with roots in older macroeconomic theories (i.e., Chartalism and Functional finance) dating to the early 1900s. Like most economic theories, it would take an entire white paper or book to explain the theory in sufficient detail, however, according to the Warren Mosler, the man credited with creating MMT-creator Warren Mosler:

The main takeaways are simply that with the $US and our current monetary arrangements, federal taxes function to regulate demand, and federal borrowing functions to support interest rates, with neither functioning to raise revenue per se. In other words, operationally, federal spending is not revenue constrained.

The implication is that any government that issues currency can always pay its bills (by issuing more currency) thus budget deficits are of less concern. While this is factually accurate, it is also only one aspect of MMT. Politicians touting MMT as a panacea are ignoring the entirety of the theory and the genuine long-term economic and social implications of excessively high debt levels.

Instead, some politicians are interpreting MMT as “free money” to advocate for constituent pleasing, but costly spending policies like a universal jobs guarantee and single-payer health care. While promises of “free stuff” will always garner votes, the reality is that the US is already facing an enormous debt load that will have to be addressed. Removing spending constraints from the government would only compound the debt problem, making any resolution (or reckoning) more painful.

If you’d like a sobering dose of reality, spend some time on www.usdebtclock.org. To those that argue, the U.S. debt level has been increasing and nothing terrible has happened in the economy, (paraphrasing DoubleLine’s Jeff Gundlach) that argument is about as sound as someone who has jumped off a 100-story building remarking as he fell past the 50th floor “so far so good.”